Shares of south-based cement maker India Cements Ltd have been falling again after a small bounce when it declared its quarterly financial results.
On a one-year forward price-to-earnings basis, the stock is trading at a multiple of around 16 times. This is cheap considering that the company is one of the largest cement producers in southern India and enjoys good brand recall in the region (see chart). Unfortunately, it’s unlikely that the company is able to bridge this valuation gap at least in the near term.
A key reason is its leveraged balance sheet.
Gross debt as of fiscal year ended March 2018 stood at ₹ 3,130 crore compared to ₹ 3,360 crore in the December quarter and ₹ 2,920 crore at the end of fiscal 2017, the company’s management said in a conference call with analysts.
However, its debt is expected to shoot up in the June quarter of the current fiscal year due to incentives and other schemes given in the beginning of the year. In fiscal 2019, the company aims to repay debt to the tune of ₹ 1,550 crore.
But what makes the situation tricky is the fact that while the company is optimistic about demand growth and remains hopeful of recovery in cement prices, it does not seem to be sure of any meaningful price improvement in the near term, analysts said.
In the March quarter, cement volume growth was hit by demand weakness in its core market of Tamil Nadu, which has been facing sand mining ban issues. While that problem has now been resolved to some extent, prices of sand remain elevated, the company’s management said. So, going ahead, much of the demand in the south should be driven by the Andhra Pradesh/Telangana region. India Cements expects the southern region including Maharashtra to grow by 10% year-on-year.
Also, a surge in variable costs and marked reduction in net plant realisation not only restricted improvement in profit growth during the quarter, but also eroded operating margins. Packing expenses, which rose during the March quarter, should continue to increase given the high crude prices, the management said.
In such a scenario, delayed improvement in prices means further pressure on margins and for the company to be able to meet its debt repayment target, improvement in profitability is a must.
Also, the company will spend around ₹ 200 crore in capital expenditure in FY19 and that can delay deleveraging.
While the company has no capacity expansion plan, the management said it has all the required clearances for brownfield expansion in three of its plants. Clarity in this regard is expected in the next two quarters.
In short, apart from a stretched balance sheet, cost pressures, absence of pricing power and lack of clarity over capacity expansion would also weigh on the stock’s performance, keeping valuations lower.
As the chart shows, the stock has fared poorly compared to peers in the last one year and may continue to trade at a discount until at least one of these concerns is out of its way.